The first type of trade we will use is selling â€œcovered callsâ€ on the stocks that we own to provide a consistent cash flow.Â The second, type of trade that we will use is â€œselling putsâ€ on stocks that we want to own at a lower price.
In this article, we are going to cover a few examples of how to manage these trades depending on what the stocks that you are playing this strategy with are doing.
Trade Management #1:Â Covered Calls
In the last article I used the following example:
Using the example of Halliburton from our first article, letâ€™s say, I purchased the stock at $34 and after checking the options chains at 3 mos and 6 mos out, I see that the 36 call 3 months from now is selling for $3 per share.Â I could sell that strike and would pocket $300 right now, about a 9% return on my moneyâ€¦in just 3 months!
Imagine if you did that 4 times per year!Â You would have a whopping 36% return on your money!
So, what happens in 3 months, if Halliburton is at 36 or Â higher?Â Even better!Â Now in addition to the $300 I made, I will make an additional $200 (I owned one hundred shares at $34 and it is now $36 or greater.Â The call was for $36, so they would pay me $36 and take the shares).Â That is $500 in 3 months or approximately a 15% return on my money.Â No bad, huh?
You are probably thinking, â€œThatâ€™s great, but what if Halliburton drops like a brick?â€Â Well, that is equally as good for us.Â I will explain more about what to do if your stock drops in our next and last article.Â Just always remember, that movement = opportunity.
As you can see from the example, if you sell the covered call on Halliburton and it is at or above that call strike on the expiration date, then there is nothing you need to do as they will take your shares from you at the higher price, giving you more return ($500 from above).Â Great!Â Turn around purchase 100 more shares and â€œlather, rinse, and repeatâ€ or purchase another one of your chosen stocks and do it with that one.Â Also, if the price is below the strike (in this case $36), you get to keep the original money ($300) and the stock and turn around and sell again!
But what happens as in the bottom part of the example if you purchase Halliburton at $34, sell the $36 call, pick up the $300, and then Halliburton drops to $29?Â If you think about it, by being paid the $300, you actually reduced your cost basis on the stock from $34 to $31 (100 shares x $34 = $3400 -$300 (call sale) =$31).Â That means your â€œbreakevenâ€ price is now $31, so at $29 you are losing $200 on paper.Â At this point, you have a few choices:
Trade Management #2: Selling Naked Puts
In the last article I described selling puts and gave an example in the following way:
The way you sell a put is simply to look 3-6 mos out in the put options chain on a stock you would like to own and then â€œsellâ€ the option at a lower price and get paid the option price.Â Sticking with our example of Halliburton from the first article, the stock is at $34, but the $30 put 3 months out is selling for $2 per share.Â Halliburton is a great buy at $30, you be happy to own it if it came down that low.Â So, you â€œsellâ€ the January 30 put strike.Â Immediately 2 things happen, you get paid $200 or approx. 7%.Â Remember, if you had to buy the stock it would be at $30, not $34 (so $200/$3000 is about 7%).Â The second thing that happens is that the $3000 is set aside in your account by your brokerage firm to cover you buying the stock if it got down to $30 by January.
That is one reason why I state at the beginning of this series that this trading style is not for everyone.Â It will work for anyone, but only some have the money to be able to do this on a large scale.Â You can, however, start out just doing either strategy on 1 stock and create the income to do either strategy on your next stock, and so on.Â Again, this is a long-term, steady cash flow way to invest.
So, what happens if you get â€œputâ€ the stock or even more importantly, if the stock drops below the price you sold the put at?
In this example, if you sold the put at $30 and picked up the $200 and 3 months later the stock is above $30, you get to keep the $200 andÂ your $3000 set aside in your brokerage account is now freed up to sell another put!
But what happens as in the bottom part of the example where you get â€œputâ€ the stock or even more importantly, the stock drops below $30 at expiration?
Well, there are few things.Â
Stop here for second.Â Do you see how over time you actually can use this strategy with both trade types to pay yourself back what you paid originally to buy the shares?Â It is so awesome when over time, you pay yourself completely back from these trades and again, and are playing with the â€œhouseâ€™s money!â€
Patience is very important. People are always anxious once they get â€œputâ€ stocks to turn around and sell the calls right away.Â We discussed at the beginning of this article series that you need to pick stocks that you are willing own for a long time and I talked before about how stocks fluctuate.Â If a stock has come down so far that you are going to get â€œputâ€ the stock or it is lower than your put strike, it means that stock has had significant movement to the downside.Â
Donâ€™t think that other people havenâ€™t noticed and arenâ€™t thinking it is a great buy at those levels as well.Â Why? Because as we have discussed when you are initially picking your stocks, they are good stocks, with good track records, probably dividend payers, so people will take the opportunity to scoop up the shares.Â
If you are willing to wait a little while (typically within a week), the stocks will go up and you can sell your call strikes at an even higher price allowing you the chance to not only get paid on the calls, but also get taken out (in the future) at a potentially even higher strike price making more money than if you have sold right away.Â I have done this many times after getting â€œputâ€ stocks and the patience has helped me as I am able to get the same call amount paid to me, but usually 1-2 strikes higher!
Well, there you go.Â A simple Cash Flow Investing strategy to help you build wealth consistently over time.Â Keep in mind that this is a very basic description of this strategy and is meant to inform you of what is available out there for you to do.Â It is not financial advice.Â There are many other tactics and management techniques that you can learn to help you make this strategy even more effective.Â In the future, we will be releasing a detailed program that shows you step by step how to do this strategy complete with video tutorials, necessary tools to help you, and complete management techniques.Â Until then, if this strategy appeals to you, start employing some of the thoughts from this article and â€œpaper tradeâ€ or trade in a play money or fake account to test it out and develop your own strategies of Cash Flow Investing.
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